Does Nutrisystem Have More Room to Run?

Mr. Market seems to like the business developments at weight-management services provider Nutrisystem, pushing its stock price up sharply over the past 12 months. Does the company still have some upside?

Weight-management services provider Nutrisystem(NASDAQ:NTRI) hasn't been a great long-term investment, as evidenced by its modest price appreciation over the past five years. The company's sales growth has been hurt over that time frame by rising competition in the diet business, a trend that has hurt the fortunes of other major players in the space, including Weight Watchers International(NYSE:WTW).

However, Nutrisystem surprised Mr. Market with a double-digit revenue increase, as well as slightly better than expected profitability, in its latest financial update. These data points led to a subsequent pop in its share price, continuing a rebound from its mid-2013 lows. So, after some good price action, does the company have more upside ahead?

What's the value?Nutrisystem is one of the major players in the diet business, primarily selling portion-controlled meals, as well as shakes and snacks, through television and online distribution channels. Like its competitors, the company has benefited from a rise in the number of people who are overweight, which the World Health Organization estimates will encompass roughly 2.3 billion people worldwide by 2015. However, turning those potential customers into buyers of its products has been harder than it would seem at first glance, resulting in a downward trajectory for Nutrisystem's top line over the past few years.

Its latest fiscal year was a continuation of the trend for Nutrisystem, as evidenced by a 9.8% decline in revenues that was a function of lower overall customer volumes. On the upside, though, the company's strategic decision to reduce promotional product giveaways improved its average product pricing. In addition, the initiation of cost savings programs, including workforce reductions, cut Nutrisystem's corporate overhead, allowing it to return to operating profitability during the period.

Looking into the crystal ballOf course, the question for investors is whether Nutrisystem can channel higher sales into profit growth, thereby creating a solid foundation for its stock price. Unfortunately, the data in that respect isn't looking great, judging by a double-digit fall in its adjusted operating profit during its latest fiscal quarter.

Also worrisome is the performance of competitors in the diet space, like Weight Watchers International, the world's largest provider of weight-loss services. Despite a major investment in its digital capabilities, the company has been hurt by a big drop-off in its meetings-based business, where attendance declined by a double-digit percentage in its latest fiscal year. Even Weight Watchers' online business, its focus of growth, saw momentum dissipate during the period, a trend that management blamed on the proliferation of free online activity trackers and diet apps. The net result for the company was a decline in operating profit, down 7.1%.

Likewise, weight-management services provider Medifast(NYSE:MED) has seen its top-line growth slow to a trickle lately, after enjoying a more than doubling of its sales from fiscal year 2009 to 2012. While the company's overall revenues were flat in FY 2013 versus the prior-year period, its weight centers segment had a relatively poor sales performance, down 6.4%, a negative trend that has caused management to seek franchisee partners for its company-owned stores. On the plus side, the strategic shift to a franchisee model has eliminated the related overhead, improving Medifast's operating profitability and providing greater cash flow to invest in product development, highlighted by the recent introduction of its new Flavors of Home line of replacement meals.

The bottom lineMr. Market seems to like Nutrisystem's recent business developments, pushing the company's share price up more than 60% over the past 12 months. Indeed, Nutrisystem showed some sales momentum in its latest fiscal quarter, with revenues up 15.9%, something that has been absent over the past few years. That said, Nutrisystem still seems to be a work in process, given its marginal profitability, which is far below the operating margins of competitors like Weight Watchers International and Medifast. As such, the company is an intriguing turnaround story, but prudent investors are probably better off watching the action from the sidelines.